Employees cannot be consultants, says taxman

Consultants have to prove they are not employees to avoid paying tax and national insurance after rule changes by the HMRC.

The Government’s new regulations begins on 6 April this year and will continue the drive to find new tax revenue.

The new legislation, The Social Security (Categorisation of Earners) (Amendment) Regulations 2014, aims to tighten further rules workers use to operate through service companies and thereby minimise their income tax and national insurance.

Service companies

Workers can  own a service company that is then used to contract with and provide services to an end user. The end user then pays a contract fee to the service company, and the service company pays out dividends to the worker, rather than a salary. The dividends are tax efficient because they escape national insurance.

Self-employment or control

To achieve its aim of increasing its tax take, HMRC have changed the self-employment classification for a worker.

Previously, the test of self-employment was whether the worker was subject to supervision, direction, or control of the end user and whether the worker was obligated to provide services himself or herself rather than through a substitute worker.

Contractor substitution clause

Service companies typically reserve the right for the service company to provide a substitute worker to the end user if they needed to.

This clause then served to show that the service contract provided only a contractor and not an employee, as the contractor provided could be replaced at the will of the service company.

HMRC believe that the substitution clauses in many of the contracts between service companies and end users were sham clauses never intended to be relied upon.

Therefore, HMRC will now ignore the substitution clause and simply look for control or supervision of the worker by any party in the chain – the service company, or the end user.

If there is control, most likely by the end user, HMRC will assume the worker is an employee and seek the income tax and national insurance that would be due.

Shifting burden of proof

To help itself in this endeavour, HMRC also gives itself the advantage of shifting the burden of proof – the worker has to prove he is innocent.

Now where an individual is employed through a service company, the Inland Revenue will assume the worker is an employee and taxes are payable. The onus is then on the service company to show there is no supervision or control of the worker anywhere in the chain. If it cannot, then pay up.